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Tax Exemptions and Residency Status

Overview

Tax exemptions and residency status affect how ProPay calculates payroll taxes for each employee. Exemptions determine which taxes (if any) an employee is excluded from, while residency status ensures the correct state and local tax rates apply. Proper configuration is essential for accurate withholding and year-end reporting.

Configure tax exemptions and residency settings for employees to ensure accurate payroll tax calculations.

What Tax Exemptions Are

Tax exemptions allow certain employees to be exempt from specific payroll taxes when permitted by IRS regulations. These exemptions are detailed in the IRS Employer's Tax Guide Circular "E."

You can exempt employees from individual taxes or from all taxes by checking the applicable exemption boxes in the employee record.

Setting Tax-exempt Status

To mark an employee as tax-exempt:

  1. Go to Employees > Add or Change.
  2. Select the employee.
  3. Click TaxStatus/Exempt.
  4. Check the boxes for applicable tax exemptions.
  5. Click Save.

100% tax-exempt employees

Check all exemption boxes to make an employee 100% tax-exempt. This feature accommodates payments to subcontractors who receive a 1099 form instead of a W-2 at year-end.

CAUTION: Low-income employees

Do not mark employees as exempt simply because their annual income is too low to owe taxes. In these cases, increase the exemptions to "99" to achieve zero withholding. The wages remain subject to taxes and must be reported as W-2 income.

SUI-exempt Wages and FUTA

If wages are exempt from State Unemployment Insurance (SUI) but subject to FUTA, you must complete the Form 940 worksheet.

Complete the worksheet if:

  • Some taxable FUTA wages were excluded from state unemployment tax
  • Any state unemployment tax was paid late (after the Form 940 due date)

Enter the amount from line 7 of the worksheet in the appropriate field. Most cases result in increased FUTA tax due to loss of state credits.

Residency Status

The residency status determines whether the employee is subject to state and local tax tables. Some states and localities have different tax rates for residents and non-residents.

Setting residency status

  1. Go to Employees > Add or Change.
  2. Select the employee.
  3. Click TaxStatus/Exempt.
  4. Select Resident or Non-resident.
  5. Click Save.

ProPay uses the residency status to apply the correct tax tables during payroll processing.

Additional State Withholding

ProPay supports withholding taxes for two states on the same paycheck. Use this feature when an employee is subject to withholding from two states or voluntarily withholds taxes from a second state.

Setting up two-state withholding

  1. Go to Employees > Add or Change.
  2. Select the employee.
  3. Click TaxStatus/Exempt.
  4. Complete these fields:
    • Additional Withholding State: Select the second state
    • Withhold this Percent of Gross: Enter percentage (if applicable)
    • Plus this fixed amount: Enter fixed dollar amount (if applicable)
    1. Click Save.

    You can enter a percentage, a fixed amount, or both.

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